SkyWest reverses 1Q loss, goes beyond anticipated break even

The result, bested the 15-July-2011 guidance that it would only break even this quarter but it only made the profit on a USD3.3 million tax benefit. Without that it would have posted a pre-tax loss of USD1.8 million.

Despite besting analyst consensus, results were down significantly from 2Q-2010 when net income was USD18.7 million on USD648.7 million in operating revenues.

The company did not provide guidance for the rest of the year.

Regional industry decline

But its statistics tell the bigger story of a regional airline industry in decline, never to return to the halcyon days of 2007 when individual company margins were above 10%. The stark contrast from those days was reflected in the fact that President Brad Rich would not even discuss margins for either the second quarter or the future.

SkyWest Airlines Net Income, Profit or Loss (System)

Source: Bureau of Transportation Statistics

While earnings recovered in 2010, from the 2008/09 period, a similar chart from the first half would show that recovery has not been sustained and, in fact, has worsened to its first quarterly loss in 23 years in the first quarter to eking out a tiny profit in the second. Headwinds will continue in the second half and into 2012 when higher maintenance costs will be ameliorated in the second quarter.

Yesterday's earnings call sounded very familiar, taking on the air of a Pinnacle call. Even so, while Pinnacles prospects will experience a significant turn around next year, SkyWest's will probably not happen until 2013.

SkyWest's headwinds of higher maintenance costs, increased crew training costs and pay, pilot shortages and lower capacity-purchase rates show just how dismal the prospects are for the industry. The earnings call compounded the impression painted by its results that it is a that has lost firm control of its operational and financial performance, a fact even acknowledged by management who indicated that many of its problems are within its control. This is true which only magnifies the challenges for all the things - fuel and last-minute changes from its partners - that it can't control.

Aggressive recovery plan

Mr Rich indicated the company has developed an aggressive action plan but did not share specifics. In addition, its protestations that it has a laser focus on its problems have grown pretty thin as the company's fortunes have declined.

Regional companies have been on a massive cost-cutting drive to try to claw back to the returns they enjoyed between 2006 and 2008 but it is unlikely they will be successful given the pressure from legacy partners to reduce costs, especially at the regional level where 50-seat regional jets have become an albatross in the face of higher fuel.

With the world's largest regional aircraft fleet at 725 aircraft, SkyWest will continue replacing CRJ200s with larger regional jets. This will result in improved operating and fiscal performance for the company. In addition, with a disparate fleet of turboprops and both Bombardier and Embraer 50 seaters, the airline acknowledged that it must streamline despite the fact that its philosophy has been that the scale of its fleet puts it in a better competitive position to win more capacity-purchase work. It inherited numerous ERJ 145s with its acquisition of ExpressJet.

Pinnacle has been saying for a few years that it will recover and indeed pegged 2012 as the start when new, higher rates from capacity-purchase (CPA) partners kick in. While Mr Rich did not discuss CPA rates, it was clear they were not going to change any time soon. Pinnacle's changed because it reached a new pilots contract which drove a dramatic increase wages and benefits.

Pinnacle Airlines Net Income, Profit or Loss (System)

Source: Bureau of Transportation Statistics

Pinnacle has been suffering since the Northwest bankruptcy and has yet to show a recovery as illustrated by its five-year, profit-and-loss look back. This year continues to show rocky results on the promise that 2012 and beyond will benefit greatly for new capacity-purchase rates.

Republic CEO Bryan Bedford even looked to inflation as the only way to increase unit revenue in its fixed fee business, citing it as the reason for the division's unexciting performance.

2Q 2011 USD	Horizon*	Republic CPA only	Pinnacle**	SkyWest***
Profit	7.4M pre tax vs 8.2M pre tax	17.6M pre tax vs 20.8M pre tax		1.5m vs 18.655M
Operating Revenues	95.4M vs 171.4M	273M up 4.9% ex fuel 245.2 up 1.7%		933.6M vs 659.7M
Total Expenses	83.8M vs 158.1M	NA		914.6 vs 600.4
ASMs	691M down 17%	2.8B up 0.6%		9.3B up 58.1%
Load Factor	84.3% up 2.4 pts	74% down 4.5 pts		80.3% down 0.4 pts
Yield cents	NA	NA		12.20 down 9%
PRASM cents	25.33 up 17.8%	NA		9.9 down 9.2%
CASM cents	NA	9.03 up 5.9%		10.00 down 4.8%
CASM cents ex fuel	12.13 vs 14.84	8.06 vs 7.86		NA

All numbers are for the consolidated company or, in the case of Republic, for its CPA ops
*Alaska Air Group restructured Horizon into a more traditional CPA arrangement eliminating its branded operations
**Pinnacle's results include the integration of newly acquired Mesaba Airlines
***SkyWest results include the integration of newly acquired ExpressJet

Republic Airways share price

Source: Centre for Asia Pacific Aviation and Yahoo! Financial

SkyWest has similar problems but also cited rising health care costs as a major factor in its results.

In a recent guidance update, the company said pilot shortages have forced it to pay crews double time and premium rates on certain flying which will reach about USD14.5 million in the second quarter. It is unclear whether it will be reimbursed for the additional costs.

Meanwhile, for SkyWest, the guidance issued in July reflects how regionals continue to be challenged by numerous headwinds including consolidation and rising fuel. For SkyWest, it was a good-news, bad-news story. Delta and United are increasing SkyWest and Atlantic Southeast block hours which is forcing additional aircraft and, because of the pilot shortage, higher crew costs. Indeed, this, and the continuing squeeze being put on regionals by major partners and the lack of growth prospects, are expected to be the continuing themes for the US regional industry from here on out.

Integration surprises

All three companies are struggling with integration problems related to airline acquisition which were largely at the behest of their major partners. These are costs that must be absorbed by the regional company. For SkyWest, it expects the single operating certificate (SOC) for the integration between subsidiaries Atlantic Southeast Airlines and ExpressJet to be accomplished on schedule by year's end. The company already realised USD30 million in annual run rate gains with more expected after it achieves SOC.

Mr Rich said that it encountered many surprises after its acquisition of ExpressJet which increased costs and tried to assure analysts that the acquisition was not more than it could handle and indeed, the fundamental strategic objectives for the move remained in play. It has already reduced costs in the integration of the Continental Express for an annual run rate of USD30 million.

One of the biggest challenges was the fact that it lost about 900 employees in the move to Atlanta and has been in furious hiring and training program ever since the acquisition in Nov-2010. It had initially implemented a plan to terminate 200.

Skywest USA share price

Source: Centre for Asia Pacific Aviation and

ASA too long in turn around

Mr Rich noted that questions have developed on whether the acquisition of ExpressJet remained a good idea, something he tried to dispel although not entirely successfully. ASA had problems of its own before it took on the integration issues with ExpressJet, largely to protect non-union SkyWest Airlines from the union shop that is ExpressJet.

Meanwhile, despite the fact that SkyWest does not break out subsidiary results, ExpressJet had a pre-tax loss of about USD10.5 million. In addition, amongst the company's items were losses to its investments in Vietnam's Air Mekong and Brazil's Trip Airlines.

Mr Rich cited the fact that the Vietnamese carrier is less than a year old and Trip was in a high-growth mode which has kept it from delivering returns on SkyWest's investment. Pre-tax losses for the two includes USD1.2 million for Trip and USD1.7 million for Air Mekong compared to a USD1.1 million profit on Trip alone in 2Q-2010. The results were not unexpected and, at least for Trip, SkyWest expects profitability by the end of the year.

SkyWest expressed its support to the proposed acquisition of Trip by TAM but said the planned investment by TAM has been delayed because of the high growth rate. The growth rate has caused Trip to miss its Ebidtar targets which also played into the investment delay.

Pro-rate operation profitable again

He also reported that its pro-rate operation in which it takes on the cost risk including fuel showed strong improvement generating an operating profit of more than USD3.1 million in operating income on 62 aircraft including 22 jets and 40 Embraer Brasilias. This compares to USD.2 million in the 2010 second quarter with 63 aircraft for an overall improvement of USD2.9 million. The turn around was despite a USD7.4 million increase in fuel costs for the pro-rate operation as the price per gallon rose 41% to USD3.65 per gallon.

Its new service with Alaska was launched successfully which Mr Rich said may lead to additional opportunities with its newest client. He also said that the disruptions caused by last minute new aircraft from other partners will lead to additional opportunities.

Mr Rich acknowledged that the company has been slow in getting the ASA act together even after more than five years of ownership. Its program began two years ago and at least one analyst questioned why is what not further ahead even with the integration of ExpressJet. It is expected that the ASA cost-cutting, operational improvements and integration of the ExpressJet operation will continue through 2013, according to Mr Rich.

It has extracted cost savings from the Atlanta-based carrier. However, partner requirements to design scheduled to optimize the mainline network have conspired to reduce utilization and stage lengths which has a depressive impact on financials.

Despite continued questions about the holding company's prospects for the future, he could do little but once again say that management is focussed on it and it realized it had to do better. That is also true at SkyWest Airlines and is likely the result of changes to the capacity purchase agreements with United and Delta in the wake of the recession.

Essentially the regional industry continues to absorb the changes wrought by the consolidation of mainline partners, the acquisition of ExpressJet by SkyWest and Frontier by Republic as well as Mesaba by Pinnacle.

Republic Airways share price

Source: Centre for Asia Pacific Aviation and Yahoo! Financial

Losing patience or just accepting the inevitable

Analysts sought colour on what SkyWest's battle plan is almost sounding very much as they do when the cross-question AMR Gerard Arpey as he dodges similar questions about his company's plans for success. And, as with Arpey, few details emerged from the SkyWest call, replaced in favour of vague promises that things will get better in the future.

The cost headwinds related to increased crew, training and pilot shortages which totaled USD32.5 million are expected to continue in the third quarter and then moderate in the fourth quarter as it continues crew hiring to address block hour increases. The crew headwinds will compounded by fuel cost overages which are also expected to continue as well the integration costs to integrate subsidiaries ExpressJet and Atlantic Southeast Airlines (ASA).

As promised the high maintenance expenses which dragged down results in past quarters is ameliorating down USD6.2 million to USD15.5 million year on year. But the USD70 million maintenance programme will continue for some time.

The company is reimbursed under its United Express agreements for subsidiaries SkyWest Airlines and ASA for engine overhauls. The company was reimbursed about USD8 million and USD9.5 million under the agreement for the second quarters 2010 and 2011, respectively. However, the number of scheduled engine events is expected to drive maintenance higher in the third quarter, compared to the second quarter but come in slightly lower in the fourth quarter.

It also lost its AirTran capacity purchase arrangement over Milwaukee but picked up new work to feed Alaska, replacing Horizon's branded service which launched in May.

More Delta problems

Delta once again dinged one of its regional partner, according to SkyWest, which reported that operating revenues during the second quarter were negatively impacted from a reduction in Delta flying at subsidiary ASA required by its contract. This cost the company USD8.6 million compared to the 2Q-2010 period.

The company continues to be challenged by its acquisition of ExpressJet and the subsequent integration with its Atlantic Southeast Airline subsidiary. It is also suffering, as it did in the first quarter, from additional crew costs on its increased block-hour production, pilot shortages and increases training costs. It also cited integration-related costs as well as losses incurred on its investments in two overseas carriers.

As with its major- and low-cost counterparts, its results reflect falling profits on rising revenues. Operating revenues grew 43.7% or USD283.9 million year on year largely owing to the additional revenue brought in by ExpressJet which generated USD235 million in the quarter. SkyWest's operating revenues increased USD38.8 million on reimbursable fuel and engine-overhaul costs. It also increased its ground handling and pro-rate revenue by USD10.5 million during the quarter having increase its ground handling agreements and laid on additional pro-rate flying.

On the expense side the company experienced a USD312.6 million or 50.2% increase in the second quarter, again largely resulting from its acquisition of ExpressJet which generated USD245.5 million in additional expenses. Excluding ExpressJet as well as fuel and engine overhaul costs reimbursed under capacity-purchase agreements, SkyWest expense increase totaled USD31 million or 5.7%.

It cited USD12.7 million pre tax in crew costs on increased block hors, pilot shortages and increased training. It also incurred USD4.4 million pre tax of simulator and lodging expense for the same reason. Its pro-rate operations, under which it is responsible for fuel, experienced a USD7.4 million per tax increase in fuel. Finally the company cited USD7 million in integration costs.

SkyWest finished the quarter with approximately USD684.6 million in cash and marketable securities, down from the USD804.9 million at the end of the Dec-2010 quarter. The company cited increases in its prepaid aircraft lease amounts and changes in certain other working capital accounts of approximately USD50.0 million for the change. It also noted it also paid USD13.5 million in deposits on its new aircraft order and USD40.3 million in authorised share repurchases.

Long-term debt was down to USD1.66 billion from the USD1.74 billion posted in the Dec-2010 quarter owing to normal debt payments.